Financial Markets
Chapter 11
Investment
 Act of redirecting resources from being consumed
today so that they may create benefits
Financial Systems
 Includes savers and borrowers and allows the transfer
of money between them
 Financial Assets: claim on the property of income of a
borrower
Financial Intermediaries
 Banks, Savings and Loans, Credit Unions
 Finance companies
 Mutual Funds
 Life Insurance
 Pension funds
 Share risk
 diversification
Investment
 Portfolio
 Collection of financial assets
 Savings, stocks, bonds, real estate
 Prospectus
 Investment report to potential investors
Risk, Liquidity, and Return
 Return: money beyond basic investment
 Risk: danger of losing money
 Liquidity: ease which it converts to money
Bonds & other Financial
Assets
 Bonds Components
 Coupon rate: interest rate on the bond
 Maturity: time at which payment to the bondholder is due
 Par value: amount that an investor pays to purchase a
bond - face value or principal
 Buying bonds at a discount
Bond Rating
 Standard and Poor’s
 Moody’s
 Rate bonds
 Highest: AAA
 Lowest: D
 Interest rates related to bond rating
Bonds Issuer’s Point of View
 Bonds Advantages
 Rate steady
 Fixed payments
 Do not own company
 Bonds disadvantage
 Company must make fixed
interest payment
 Cannot change interest rate
 Bonds can be downgraded;
harder to sell
Types of Bonds
 Saving Bonds
 Treasury Bonds, Bills, Notes
 Municipal Bonds
 State Bonds
 Corporate Bonds (SEC)
 Junk Bonds: low ratings, high interest rates
Other Types of Financial
Assets
 Certificates of Deposit
 Money market
 Mutual Funds
Financial Asset Markets
 Capital Markets: long term CD, government &
corporate bonds
 Money markets: short term CD, Treasury Bills
Primary & Secondary Markets
 Primary markets: redeemed only by original holder
 Secondary markets: financial assets resold
 Shadow banking
 Collateralized debt obligations
 Trenches
Stock Markets
 Buy shares / equities
 Benefit: dividends
 Capital gains / capital loss
Types of Stock
 Common Stock
 Vote; no guaranteed dividend
 Preferred Stock
 No vote; guaranteed divided
 Income stock
 Growth stock
 Stock split
Trading Stock
 Stockbroker
 Brokerage firms
 Stock Exchanges
 New York Stock Exchange
 NASDAQ
 Over the Counter market (OTC): electronically traded
Futures & Options
 Futures: contracts to buy and sell at a specific
date; at a specific price
 Options: contracts that give investors the choice to
buy or sell stock and other financial assets
 Call options: buy stock shares at a specified time in
the future
 Put option: option to sell shares of stock at a
specified time in the future
 Daytrading
Measuring Stock
Performance
 Bull market
 Bear market
 Dow Jones Industrial Average 1896
 S& P 500
Great Crash of 1929
 Investing during 1920
 Signs of Trouble
 Speculation
 Crash
 Aftermath
 4 million invested - lost money
 Monetary policy - tight money policy
Domestic Causes Great
Depression 1929
 Downturn in Spending 1930
 New instability from credit-based spending
 Belt-tightening to avoid default
 Collapse of financial sector
 Loss of confidence in banks
 Deflation => rise in real debt burden
 International Aspects
 World commodity price fall 1930
 The Gold Standard
International Factors in Great
Depression
 Breakdown of International System
 War Debts and Reparations
 Loss of British Leadership
 World Deflationary Spiral 1929-1933
 Absence of (U.S.) Leadership? [Kindleberger]
 Gold Standard [Eichengreen and Temin]
 Smoot-Hawley Tariffs: 60%
Great Depressions 2 / Great
Recession 2008
 Faster policy response
 No protectionism
 Bank deposits safe
 Some safety-net in place: Social Security,
 More flexible labor markets
Medicare